China's economic recovery is underway, but the country's property sector and banking system face rising risks as mortgage boycotts have hit home. However, we believe China has both the policy tools and the political will to manage the situation.
- Just as the prolonged lockdown of Shanghai becomes a thing of the past, mortgage boycotts or strikes have erupted in 80 cities across the country, threatening the best assets held by Chinese banks on their balance sheets. Indeed, some observers have started to label this emerging property market risk as China’s Lehman Moment (again!).
- The potential impact on financial and social stability has already accelerated the policy response, with a potential grace period being proposed for borrowers, as well as proposals for more coordinated financial and administrative policies to speed up project completions.
- The size of the mortgage boycotts remains relatively small at this stage. However, if allowed to fester, the potential damage to the banking system could be large. It is estimated that the nonperforming loans (NPLs) from mortgage strikes alone could amount to 1.4% of banking system, assuming 9% of housing units sold in pre-sales go on mortgage strike. This nearly doubles the current NPL ratio of 1.79% at the banking system.
- We believe China has both the policy tools and the political will to keep this tempest of mortgage strikes in a teapot. In particular,
- Halt the implementation of the ‘three red lines’
- Instruct local governments to take a decisive role to accelerate the restructuring of defaulted developers, and deploy the pre-sale funds to complete the troubled property projects
- Continue to manage expectations by removing factors that could undermine the recovery of the property market.
- As a result, we believe the situation is manageable, as some of the needed measures are already being taken. In fact, the mortgage strikes may have accelerated a part of the stimulus program that had seen the least progress. We maintain our view that the episode of mortgage strikes won’t derail China’s cyclical recovery in the second half.